Mexico and Trump trade policies: it’s complicated

By: | Issue #658 | at 09:51 AM | Channel(s): International Trade  

A faltering NAFTA could increase U.S. trade deficit and have other side effects.

Mexico’s position among Latin American economies is particularly sensitive to Trump administration trade policies because of its high level of trade exposure to the United States and because of President Donald Trump’s obsession with redressing trade deficits. But if Trump makes good on his threats to terminate NAFTA, or should the renegotiation talks falter, the likely result will be counterproductive to Trump’s aims. That’s because the Mexican peso will fall, by as much as 25%, according to some estimates, making Mexican products cheaper in the US and increasing the deficit.
To be fair, the demise of NAFTA would represent a multi-faceted problem for all concerned. A falling peso could encourage Mexican imports and U.S. investments in Mexican manufacturing but it could also increase costs to Mexican manufacturers in some areas, such as the price of U.S. natural gas.

The global credit insurer Coface recently released a report outlining possible outcomes of U.S. trade policies for Latin America. Costa Rica, El Salvador, and Honduras are all vulnerable to any eventual import measures imposed by the United States. But Mexico’s position is particularly sensitive because of the Trump administration’s articulated policy to focus on countries with a strong trade surplus with the U.S.

It’s questionable, to say the least, whether U.S. trade policy should be based on the extent of the deficit with any given trading partner. In the case of Mexico, the trade deficit picture is far more complicated than it is being portrayed by some politicians.

Peso Fallout

According to the Peterson Institute for International Economics, if NAFTA was to come to an end, the Mexican peso would devalue by more than 25%. Mexican-produced cars would be likely to become more competitive in the United States, which would further add to the trade deficit in contrast to what the administration is trying to achieve.

Despite Trump’s threat, as recently as August 28, that he would likely terminate NAFTA, currency markets are assuming smooth sailing toward a renegotiated NAFTA at the moment. But it wasn’t always so. When Trump won the election, the peso sank more than 10%. In January, amid talk of a possible US withdrawal from NAFTA, the peso dipped five percent. Rumors in April that Trump was about to sign an executive order to withdraw led to another five-percent drop.

The currency markets are currently quiescent, but Caroline Freund, who wrote the Peterson report, warns that “the renegotiation talks could still get derailed.” “And what we have learned from these past experiences,” she added, “is that if NAFTA is scrapped the peso will plunge.”

Caroline Freund – Peterson Institute for International Economics
Caroline Freund – Peterson Institute for International Economics

If Trump’s problem with NAFTA is the growing trade deficit with Mexico, then talk of withdrawing from the agreement and slapping tariffs on Mexican imports would be counterproductive, according to Freund. That’s because, the more the peso falls, the cheaper and more competitive Mexican imports become, yielding an even higher trade deficit. A U.S. withdrawal from NAFTA, in other words, would, in Freund’s words, “very likely expand in the absence of NAFTA.” So could U.S. investments in Mexican manufacturing capacity, a phenomenon that has aroused the presidential ire. But manufacturing costs in Mexico is a multi-edged sword, and the demise of NAFTA could wreak havoc on Mexican manufacturing, U.S. importing, and Mexican emigration, another touchy subject.

The benefits of a peso devaluation don’t extend to every area of a manufacturer’s business, according to a recently-released report from Entrada Group. Mexico’s competitive advantage predominates in labor costs, especially as the peso devaluation’s side effect includes an appreciation of the Chinese RMB, which increases labor costs in that country.

On the other hand, costs such as construction, utilities, and telecommunications, the Entrada report points out, “are often at a premium in Mexico because such infrastructure elements are financed in U.S. dollars.” As an emerging market, Mexico’s costs to finance in dollars is much higher than it in developed areas like the United States or Europe. “It’s important for manufacturers contemplating a Mexico footprint to look beyond the workforce,” says the report, and consider all the costs they will incur.

Wild Card

Another wild card is the easy export of U.S. natural gas to Mexico. Mexican manufacturers have come to rely on imports of cheap U.S. natural gas to fuel their growth, noted Jason Bordoff, a former energy adviser to President Obama, in a paper published by the Center on Global Energy Policy at Columbia University. Under NAFTA, Mexico receives gas as a “free trade country,” which reduces the regulatory requirements for exports. Should that situation end, exporting U.S. natural gas to Mexico will be accompanied by a more heavier regulatory burden and, therefore, become more expensive, increasing costs to Mexican manufacturers.

Jason Bordoff, energy advisor
Jason Bordoff, energy advisor

The Entrada report agrees that Trump’s trade policies, in the form of tariffs on Mexican imports, if it comes to that, could drive down the peso’s value. But, the report cautions, “tariffs also have the potential…of creating havoc in the Mexican domestic economy, which could lead to political strife in Mexico as well as increased immigration to the United States and the rest of world,” another trigger for Trump.

Factors that enter into currency exchange rates are notoriously complicated, and manufacturers should not assume, warns Entrada, that the cheap peso will last forever. The key correlation to peso value is the price of oil, according to Entrada, and if oil prices go up, as they have in recent days, so will the value of the peso.

Peter Buxbaum's avatar

American Journal of Transportation

More on Peter Buxbaum

Peter Buxbaum has been writing about international trade and transportation, as well as security, defense, technology, and foreign policy, for over 20 years. Besides contributing to the AJOT, Buxbaum’s work has appeared in such leading publications as Fortune, Forbes, Chief Executive, Computerworld, and Jane’s Defence Weekly. He was educated at Columbia University.